Sarbanes-Oxley and Health Plans

The structure of employee health plans often obscures the view of benefit costs and internal controls that the Sarbanes-Oxley Act demands.

Among the many compliance perils created by the Sarbanes-Oxley Act of 2002, one of the least talked about could well be the act’s effect on corporate health-benefit programs.

The lack of discussion is understandable. To be sure, benefit managers commonly operate under the wing of human resources executives, who in turn report up to chief financial officers. Yet finance and HR often seem to live in two different worlds. That’s been especially true since the passage of Sarbanes-Oxley: While finance executives have scrambled to comply with new reporting and certification requirements, benefits caretakers have largely watched from the sidelines.

That’s changing. Under Sarbanes-Oxley Section 302, CFOs and CEOs must certify that their companies’ quarterly and annual filings are true and that they omit no material facts. And facts about employee health care are becoming nothing if not more material: Employee benefits now typically represent a company’s third-biggest expense, trailing only cost of goods sold and non-manufacturing payroll, according to a report published earlier this year in The McKinsey Quarterly. Health insurance is the fastest-rising component; between 1986 and 2003, it climbed at an annual compound growth rate of 6.7 percent. By comparison, the report noted that government-mandated benefits — including Social Security, Medicare, unemployment insurance, and workers’ compensation — rose 5.3 percent during that period.

What’s more, in order to sign off on those filings, finance chiefs arguably must have some grasp of the statements’ underlying content. That can be an especially formidable challenge in the retiree-benefits arena, where a transparency-challenged accounting system holds sway. The system’s volatility-smoothing techniques — projected out over decades — may obscure real cash demands. (For more on the accumulating cloudiness of retiree-benefit accounting, see “Prescription Change” in the June issue of CFO magazine.)

Determining a company’s future benefit burden, in turn, involves the mystifying task of predicting the future of health-care costs. The alarmingly sustained double-digit inflation in benefit expense over the last five years, coupled with “the inherent complexity of the health-care supply chain,” make such forecasting extremely difficult for individual companies, says Sreedhar Potarazu, president and chief executive officer of VitalSpring Technologies. (In this context, supply chain means the complicated billing, service, and financial connections among employees and retirees, doctors and hospitals, employers, insurers, and third-party administrators.)

And when wide-of-the-mark forecasts lead to errors on the income statement, those errors can build on themselves and invite unwanted attention from investors and regulators. “This has a cascading effect,” says Potarazu, whose company provides software that culls corporate health-benefits data. “When previous estimates turn out to be inaccurate, increased scrutiny is inevitably placed on the processes and controls behind those predictions.”

Sarbanes-Oxley Section 404 has already trained the spotlight on Corporate America’s internal controls for financial reporting. Given the increasing national focus on the cost of health care — witness the recently-passed Medicare reform law — some finance departments have already found it prudent to take a closer look at the intersection of employee benefits and internal controls.


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